Misplaced loyalties

Economist

Commentary

It has been well documented that people working under an authoritative figure, can be manipulated into obeying orders that are contrary to their conscience. It takes observance to a higher power, either religious or secular, to stand up against the immediate authority, to stand up for what is right. Misplaced loyalties have led many astray. It's why independent regulatory oversight is absolutely essential.

Excerpts

HOW did Bernie do it? With an old IBM computer, oodles of chutzpah and, it seems, help from multiple sidekicks. On Tuesday August 11th Frank DiPascali, the senior lieutenant in Bernard Madoff’s bogus fund-management business, admitted to fraud and was arrested. His willingness to confess and, apparently, to co-operate—in contrast to Mr Madoff, who went to jail insisting he acted alone—is a coup for prosecutors. They will waste no time going after the unidentified “other people” with whom Mr DiPascali says he and his boss perpetrated the scam.

Mr DiPascali was the main point of contact for investors, who ranged from Jewish charities to film moguls. He also oversaw the mechanics of the vast Ponzi scheme. It purported to be making steady, double-digit returns trading options on a share index. In fact, client funds sat in an account at JPMorgan Chase and were withdrawn only to meet redemptions or to be parked in Treasuries and the like. This was “nothing more than a slush fund”, according to the complaint against Mr DiPascali by the Securities and Exchange Commission.

Though there was no actual trading, the conspirators were far from idle. They cooked up phantom trading records, client confirmations and account statements to corroborate the fictitious investment strategy. They made thousands of wire transfers between the firm’s London and New York offices to make it look like it was earning commissions from real transactions.

Hindsight is a wonderful thing when cooking the books. The complaint says that Mr DiPascali “picked advantageous historical prices, often near the lows, to create the appearance of a profit once the purported trade was booked.” A single computer was programmed to allocate trades, pro rata, to individual accounts.

Some of the ruses bordered on comical. Worried that returns were suspiciously high, Mr Madoff occasionally instructed Mr DiPascali to book fake trades designed to lose money. They even created a fake computer platform so that, should outsiders spring a surprise visit, they could be shown “real-time” trading.

Absurd, perhaps, but not amateurish. The two made full use of their deep understanding of the workings and oversight of stockmarkets to pull the wool over inspectors’ eyes. They created a list of counterparties that were unlikely to be checked on: European firms for American regulators, and vice versa. They pretended to exit their options-trading strategy and shift into Treasuries before the end of each quarter, to avoid having their fishy positions disclosed in investors’ filings. To hide the scale of the operation, which had thousands of accounts, they devised a subset of 10-25 “special” accounts, which they presented as their full universe of business. Why regulators swallowed this, when Mr Madoff was widely known to have had hundreds of clients, is a mystery.

Who else was involved? Prosecutors have filed charges against the firm’s accountant, who denies them. They are looking to build cases against certain investors and “feeder” funds that funnelled their money to Mr Madoff. But the most fertile territory could be the co-workers whose help would have been needed to handle the programming and the mounds of paperwork. In court, Mr DiPascali lamented becoming “loyal to a terrible, terrible fault.” In that, he was surely not alone.